"They claim the Q122 demand 99.28mb/d less supply 98.83mb/d is a deficit of 0.45mb/d. Their forecast also sees FY22 demand being higher than either 2018 or 2019. Given rising interest rates I find this pretty hard to understand with most commentators calling a recession. S&D seem pretty aligned to me. At least as well as they were pre pandemic."@Patient,
I suspect the thing you are overlooking is oil's high degree of demand in-elasticity, even during periods of economic slowing.
Evidence of oil's high demand in-elasticity is unambiguous: in the past 42 years(which is as far back as I've been able to find data), demand has contracted on just 4 separate occasions (shown by the red columns in the chart below).
On three of them, it was due to extremely abnormal black-swan type events, as opposed to a conventional economic recession, namely:
- the Middle East crisis which cased the oil price shock of 1980 (3.2% decline in demand across 1982/83),
- the 2008/09 GFC which was really a major systemic liquidity crisis which caused US GDP to contract by 2.6% and the Eurozone by 4.5% (- and even then global oil demand fell by just 0.8%), and
- Covid in 2020.
The only one occasion that global oil demand fell during a normal economic recession was in 1993 which was the peak of the painful global synchronised slowdown of the early 1990s.
And even then the reduction in demand was barely noticeable (a mere -0.3%).
So, self-evidently, global oil demand growth is relatively consistent over time and shows very limited contraction during normal economic cycles.
What causes oil prices to peak and fall are therefor not demand-related, but the significant increases (or under-investment) in new supply in the preceding years.
The lead times for the development of new capacity are long, so what happens to the oil price at any given point in time is determined by what the industry was doing in the preceding 4 or 5 years in terms of investing in capacity.
For example, the price spike that was experienced during 2006/07 was an outworking of the under-investment in new capacity between 2002 and 2006, when oil prices were in the doldrums.
According to the IEA, over that period an average of US$300m pa was spent by the global industry on upstream exploration and development (industry experts such as Wood Mackenzie estimated at the time that just to maintain production at existing levels required about US$500mpa).
The result was an under-supply situation that stated in 2007 and continued for a few years thereafter.
In response, the oil industry ramped up investment in capacity, and between 2010 and 2015 global upstream capex averaged around US$700m pa, peaking at US$770m in 2015:
[Source: International Energy Agency]
This investment surge lead to the inevitable oversupply which caused the oil price to fall to around US$60/bbl-US$70/bbl.
Again, as is the usual case with commodity businesses, low prices resulted in reduced capex for the next several years, with the industry not quite investing enough to keep the market in balance. (Remember that while supply spluttered, demand continued to grow steadily by around 1.5%pa over this period.)
Market tightness started to emerge in 2019 (global inventories started falling from 2017 and had fallen by over 200 mn bbl from their highs by 2019); the oil price starting to reflect the tightening situation, rising to around US$80/bbl.
And then Covid struck which threw everything into disarray during 2020 and 2021.
With Covid now behind the world, global crude demand has risen back to 2019 levels (and that's even before all global economic activity has fully recovered, e.g. air travel, international trade and a large part of China's economic activity has been hamstrung in recent months by lockdowns).
So Demand now back to normal growth patterns - even with the slowdown in the EU and US economies, the EIA is still forecasting demand growth of 1.9mn bbl/day in 2023, to 101.7mn bbl/day (so up 1.9% on 2022's 99.8m).
Demand therefore continues to be robust (driven from better-than-expected demand growth recovery from the US and from developing countries, such as India).
But what about the all-important Supply side?
Investment in Supply has stalled - not just because of Covid (during which it fell to a near
20-year low, and in nominal terms, too) but it has barely recovered from Covid levels and won't recover due to all the well-documented ESG and climate activism reasons.
So we have already had 6 years of under-investment in new capacity (2016-2022), which is already a very long capacity investment strike but - unlike previous cycles when capital would be deployed to increase supply and thereby moderate prices -
this time there is no let up in sight to the chronic under-investment.Which explains why global crude inventories are falling sharply and are currently at multi-decade low levels.
And it also explains why oil prices remain stubbornly ensconced near decade-highs, despite the US economy contracting in Q1, the OECD economy slowing and a large part of China's economy having being shuttered in due to Covid restrictions. (Oh, and also despite the US and other IEA countries releasing 240mn bbl from strategic reserves onto global crude markets, let's not forget!)
Ordinarily these sorts of adverse market factors would see the oil price down at US$70/bbl or even lower.
But this time is different.
This time the market knows that - unlike previous times of high prices when new supply was bound to come and spoil the party -
this time there is no new supply forthcoming.In this regard, you've made specific reference in the OPEC report to the US increasing supply from 18.2mn bbl/day in Q1, '22 to 19.69 mn bbl/day in Q4,'22.
So, an increase of ~1.5mn bbl/day.
Well, I have to say, I think that's going to be incredibly hard to achieve because YTD crude production is only 0.1 mn bbl/day higher, currently running at 11.9 mn bbl/day
The difference between the 11.9 mn bbl/day and OPEC's figures is that OPEC includes biofuels and NGLs (non-gas liquids, e.g., ethane, propane, butane, pentanes), which are derived from natural gas production - which is also relatively static, YTD.
So it implies all the growth is going to come from biofuels, which sure is a lot of extra US corn that is going to need to be planted!!
On specifically the US crude and NGL components, it is very hard to see that increasing much given the current levels of output are being sustained by the industry drawing down on the its inventory of Drilled-But-Uncompleted Wells (DUCs), which was created between 2017-2019 when the industry had over 820 rigs in the field. Today, despite the high oil and gas prices, there are still only 580 rigs mobilised.
The result is a drawdown of DUC's over the past two years, from almost 9,000 to just over 4,000. So there are not enough rigs to maintain essential DUCs and if you use up all your DUC inventory, your production inevitably starts to fall.
So, while I'm not predicting it will definitely happen, but if crude and NGL production from the US starts to slip at some point over the next 12 months, it would not come as a surprise to this little chipmunk. One thing is for sure, that outcome is one that the market is certainly to contemplating.
In summary:
1. Demand Inelastic and Rising2. Supply Not Keeping Up.[It's very difficult to find holes in what is a very bullish argument for oil prices for the foreseeable future.I know I've tried to find the holes and absent the sky falling on our collective heads, the most negative case I can come up with for crude prices is the structural bottleneck in global refining capacity - and even then its hardly crippling to the positive thesis; merely caps some of the likely upside.]
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(20min delay)